Summary

This article is an excerpt from Charitable Gifts of Noncash Assets, a comprehensive guide to illiquid giving by Bryan Clontz, ed. Ryan Raffin. Published by the American College of Financial Services for the Chartered Advisor in Philanthropy Program (CAP), with generous funding from Leon L. Levy. For a free digital copy, click here, and to order a bound copy from Amazon, click here.

Gifts by the Corporation

Although most of the focus is on charitable gifts of interests in closely held businesses, sometimes it makes sense to consider a charitable contribution by the business entity. This can be a particularly effective strategy for gifts of highly-appreciated, underproductive assets, whether outright to a charitable organization, or to a term-of-years charitable remainder trust for the benefit of the business entity. Based on the very broad definition of “person” contained in IRC section 7701(a)(1), the Service has ruled that C corporations, S corporations, or partnerships may establish charitable remainder trusts of this nature.

Unlike individual taxpayers, C corporation contributions are deductible up to only ten percent of the corporation's taxable income, which they must compute without regard to certain special deductions for corporations (under IRC sections 241, 243-247, and 249), any net operating loss carrybacks (under section 172), and any capital loss carry- backs (under section 1212(a)(1)).

Corporations making large charitable contributions must be careful not to violate the “new” regulations under IRC section 337, which continue the repeal of the General Utilities doctrine. The new regulations were generally effective as to transfers of assets occurring after January 28, 1999. Under these regulations, a taxable corporation is legally required to recognize gain or loss upon the transfer of “all or substantially all of its assets to one or more tax-exempt entities.” With certain exceptions, the rule also applies in the event of “a taxable corporation's change in status to a tax-exempt entity.” It specifically applies to transfers both to tax-exempt organizations and charitable remainder trusts.

The determination of whether a corporation has transferred “substantially all” its assets looks to all the facts and circumstances under the general rules of IRC section 368(a)(1)(C). The Courts generally have considered a variety of factors in determining whether a corporation has transferred substantially all of its assets. These include the corporation’s percentage of assets transferred, the types of assets retained, the purpose for the retention of assets, and the liabilities of the corporation prior to the transfer.

A business entity’s creation of a charitable remainder trust can enable sale of contributed appreciated assets with no capital gains cost. An illustrative ruling is Private Letter Ruling 200644013. In that ruling, an S corporation proposed to contribute appreciated real property to a 20-year term charitable remainder unitrust. The Service ruled that there would be no built-in gain recognition upon either the contribution to the trust or the trust's sale of the property within the 10-year recognition period.

Contributions to Charitable Lead Trusts

A charitable lead trust (CLT) can be set up with C corporation stock as its underlying assets. The CLT will need to pay tax on any income it received, even if that income is not distributed. For closely held businesses, the double taxation at both entity and CLT levels is noteworthy. However, the IRS allows an income tax deduction on amounts the CLT then distributed to nonprofits.

Families with significant wealth may consider using charitable lead trusts to minimize transfer taxes as that wealth shifts to younger generations. When that wealth derives from C corporation holdings expected to appreciate in value, the family can structure the lead trust in such a way as to reduce estate taxes. Further, the CLT can direct distributions to a family foundation for additional influence or control over the use of the funds (although if the donor controls the foundation, the trust assets will be included in the grantor’s estate).

The IRS heavily taxes charitable trusts with excess business holdings. Generally, holdings are excessive if disqualified persons own 20 percent (35 percent where a third party has effective control) or more of the voting stock of incorporated business and the CLT owns more than 2 percent. The CLT has five years within which to dispose of excess holdings. Nevertheless, caution is advised when funding a CLT with interests in a closely held business. While the taxes on acts of self-dealing and taxable expenditures will still apply, the taxes on excess business holdings and jeopardizing investments do not apply if, at inception, the value of the charitable “income interest” is 60 percent or less of the initial value of the entire trust property. The regulations define “income interest” to include a guaranteed annuity or a unitrust amount.

Since donors often design charitable lead trusts with the long-term in mind, unexpected changes to their business or families can have resulting impact on the CLTs. The IRS has ruled that in some cases, grantors can modify the terms of their CLT. For example, these can involve early termination or extension of the term with early distribution.

The IRS has allowed early termination when the closely held business underlying the CLT merged with a publicly held company, meaning the CLT received easily liquidated stock and dividends far in excess of the annuity amount. The grantor and trustees attempted to prepay the amounts owed and dissolve the trust. The IRS allowed this arrangement since the distributions were made for the charitable purposes originally intended, and since no disqualified person would receive any additional benefit. The key factor is that the prepayment was of the entire remaining amount without dis- count—so essentially the only change was to the timing and lifespan of the CLT.

In another case, the donors used appreciated trust assets to extend and restructure the CLT. The agreement stated that the trustee was to distribute all assets exceeding 110 percent of the remaining obligations to the remainder beneficiary, and the annuity would be extended such that the remainder interest would be close to zero. The IRS ruled this modification was allowable, and that it was not subject to penalties for self- dealing, early termination, nonexempt assets or purposes.

C Corporations Additional Resources

Below are further details on gifts of C corporations. C corporation topics are based on Turney Berry and Jeffrey Thede’s “Giving the Business to Charity: Charitable Planning with Closely Held Businesses,” and Turney Berry’s “Charitable Planning with Closely Held Businesses.” For quick take-aways on C corporation gifts, see C Corporations Quick Take-Aways. For a review based on the articles, see C Corporations Intermediate. For an in-depth examination adapted and excerpted from the articles, see C Corporations Advanced. For further details, see C Corporations Additional Resources.